I am back. Sorry for the long hiatus.
My last entry discussed extended duration treasuries and their role in a portfolio. If you have been listening to financial industry experts and commentators during the spring and summer you may have been inclined to avoid mid to long duration treasuries. Some commentators have even suggested that you avoid bonds altogether and load up on dividend paying stocks or stocks with a history of increasing dividends.
I am not one to dissuade investors from investing in defensive stocks, high dividend stocks or stocks that regularly appreciate their dividend payout. However, discouraging people from owning bonds and especially treasuries in an environment that is at best volatile and at worst deflationary is bad advice. In mid July when I discussed EDV (Vanguard Extended Duration Treasuries ETF) the price was $82 per share. Today the price is close to $118 that’s a 44% increase in about 5 months. No other asset type has even come close to such a performance. These bonds pay just over 3% and have an average duration of 27 years.
If you have benefited from my advice and made a 44% return on EDV then congratulations. But, one thing should be clear before you assume I am a “genius” and start expecting regular tips that will perform in spectacular fashion – I did not know that EDV was going to out perform other assets when I wrote to recommend that investors hold some in their portfolios. I was merely suggesting EDV as insurance against a downturn in the stock market. Keep in mind that EDV is very volatile but it moves in the opposite direction to stocks. What is surprising is that the level of appreciation has been much more than the decline in stocks. I think it may indicate the level of fear investors have in the current market valuation.
Investors should not purchase EDV at this time. The price is very high. I would wait until it is at or below $100 per share.
The August 2nd deadline for increasing the debt ceiling is fast approaching. If the debt ceiling is not increased, the US will be in unchartered territory. The US government taxes and borrows to fund its operations. With the ability to borrow abruptly stopped, it is possible that some checks such as Social Security, Medicare, Medicaid, and unemployment compensation will not be paid. Even if the debt ceiling is raised the rating agencies will most likely downgrade US government bonds from AAA to AA. Ultimately, the US government will pay its obligations but the damage to the US credit rating has already been done. As a result of the political theater we have witnessed in the pass few weeks, US debt will be downgraded for the first time in history.
What should people do? It is difficult to know what, if anything, should be done. A few weeks ago, I wrote about Extended Duration Treasuries. I recommended that those who want a hedge against a market downturn should consider holding an ETF such as EDV which is made up of long-term treasuries. Ironically, these US government obligations, are likely to go up in times like these. When treasuries were considered default free (that is what a AAA rating means) investors rush to them as the last resort to safety. Many wonder if the downgrade will affect the “safe haven” status. I think not. There are no alternatives. The Euro denominated debt is riskier and gold if very hard to asses especially at the current peak price at more than $1,600 per ounce. Last week the market dropped by close to 4%. By contrast, EDV moved up by 3.32%.
I am not suggesting that investors should rush and purchase treasuries in large amounts because of what might happen next week or next month. We believe that investors should have a long-term view and not react to market movements on a short-term basis. Investors who have not built a diversified portfolio should read the investing section of this blog, and build a portfolio tailored to their needs. Within an investor’s portfolio, funds like EDV can play an important role as a hedge against market downturns. At least while there is no alternative US treasuries.